Not an Easy Year Ahead for Bankers

This new century didn’t start very wellu00e2u20ac”terrorists and recession took care of the Happy New Year. Bankers did better than most because banks always are the last to really feel a recession. So 2002 is likely to be a trying one for banks. Here are some thoughts on the outlook.

First, based on past history, this recession, even if it’s a long one by historical standards, should be over by 2003. There are some signs already that we are bottoming out, including my favorite indicator, the Purchasing Managers Report (now called the Institute for Supply Management), which has moved up for the last couple of months, though it is still in recession territory. I doubt that we’ll see the end of low growth and profit squeeze much before 2003, however.

Second, the comptroller of the currency says banks will have to reserve $25 billion in 2002 (against about $15 billion in the last three quarters of 2001), reflecting the credit problems of this recession. I wouldn’t be surprised if “his controllership” is a bit low. Reserving at this level means pressure on profits, which will be worse for the big banks than for community banks. If banks can match 2001 profit levels, it will be a real accomplishment.

Third, there’s a whiff of deflation in the airu00e2u20ac”pricing of the consumer purchases index was down for the first time in over 40 years. We haven’t worried about deflation since the Great Depression. Japan has had a deflationary economy for the last couple of years, which proves it can happen anywhere, even to the world’s second-largest economy. If we do have a deflationary period, it will be very hard on profits, and on debtors, and thus on banks.

Fourth, falling oil prices have been a great cushion for this recession and probably have helped the economy almost as much as the Fed’s rate cuts. But OPEC is cutting production, and thus oil costs may soon be increasing manufacturing costs rather than decreasing them. A new factor in the oil picture is the emergence of Russia as the second-largest oil exporter after the Saudis. Russia is not a member of OPEC and will follow its lead only when it is good for Russia.

Russia’s increased production is largely due to the new presence of U.S. and other western producers as joint ventures in the Russian oil fields. How the world has changed! We’ve helped the Russians to become a major influence in setting prices for oil. Let’s hope they will use this power to keep prices down.

Fifth, debt levels continue to rise both at the corporate and consumer levels, credit card debt is at record levels, and new credit is readily available. Personal bankruptcies are at all-time highs; corporate junk bonds are also defaulting in rapidly increasing numbers. If there is one thing that will slow an economic recovery, it is these record debt levels. In this recession, so far, consumer debt has not dropped as it normally does during an economic slowdown.

Sixth, it seems likely that deposit insurance reform may make its way through Congress in 2002. This involves many issues important to community banks’ future, particularly increased deposit coverage and fairer premium requirements.

On the optimistic side, productivity numbers continue to be relatively strong for this kind of an economy. If productivity can go back to the ’95-’00 levels, around 3.5%, many of the economy’s problems will be taken care of. Profits will be on the increase and so will personal income. Watch that productivity number: It will be very important in predicting where the markets are headed.

So, for 2002, predicting a boom recovery is hard to imagine, no matter how much we’d like to be able to do so. My guess is that the Dow and NASDAQ will be close to where they are now when 2003 rolls around. Interest rates ought to be going up by year-end. The move of U.S. budgets from surplus to deficit will be a major factor in affecting interest rates. It was wonderful to hear from Alan Greenspan that U.S. budget surpluses were ahead as far as the eye could see, or at least 10 yearsu00e2u20ac”I never did believe it.

Forecasts are tricky to be sure, and these are the six areas I am relatively confident about for 2002. One thing you can always count on, though, is if you keep your customers happy, it will be a Happy New Year for banks.